With a growing pressure on real estate syndicators and financial institutions to generate larger volumes and mergers sweeping the banking and other industries, some affordable housing executives have begun to detect merger and consolidation clouds on the horizon.

"You will see a shake up of smaller players in the next year or so. Financial institutions want volume, and only larger players have the ability to move quickly and generate large volumes," says John Manning, president and chief executive officer of Boston-based Boston Capital, one of the nation's top providers of equity capital for affordable housing, with a $5.5 billion portfolio. "I would definitely consider acquiring smaller companies."

One major sign of potential mergers and acquisitions in the industry is a number of strategic alliances or linkages being established between major banks and real estate syndicators of affordable housing.

Boston Capital, for example, late last year entered an agreement with Bank of America to market low-income housing tax credit (LIHTC) investment funds to corporate investors. Under the initiative, Boston Capital will underwrite and acquire properties located in California that have received federal and state tax credits. Bank of America's Leasing and Capital Group will market up to $100 million in funds composed of multiple tax credit properties to California financial institutions, including Bank of America's correspondent banks and thrifts.

"I am very pleased I have that relationship," Manning says. "There are many alliances being established between major banks and syndicators."

Banc One Capital Corp., the investment and merchant banking arm of Columbus, Ohio-based Banc One Corp., and Boston -based Boston Financial, one of the affordable housing industry's largest real estate firms, have also formed a strategic alliance. Under the agreement, Banc One Capital will make a non-voting investment in Boston Financial to provide it with additional working capital to expand its business. Both parties also intend to explore the feasibility of leveraging their real estate investment banking and investment competencies.

Industry sources say Portland, Ore.-based The Arcand Co., a national sponsor specializing in middle market transactions in affordable housing, and PNC Bank Corp. of Pittsburgh are currently in serious negotiations that may result in PNC acquiring Arcand. Bradley Bullock, director of acquisitions at The Arcand Co., declined to comment on the potential merger. PNC Bank officials could not be reached for comment before the press time.

"You are already seeing these linkages. They may eventually lead to their mergers," says Michael J. Novogradac, president of Novogradac & Co. LLP, a San Francisco-based accounting firm that specializes in affordable housing. "You have large players who need large volume to generate economy of scale. Consolidation in affordable housing will happen."

Declining yields Novogradac says talks and possibilities of impending consolidation and mergers in the industry are reflective of declining yields on investments in affordable housing programs. Yields are currently averaging 9% as compared with 35% to 40% in the early 1990s.

"There is a lot of capital in the market and that is why yields are falling," Novogradac says. "It is a core principle of supply and demand." But he rejects the notion that if yields keep falling, corporate investors that invested heavily in LIHTC programs in the 1990s may withdraw from investing more in the industry.

"Before that happens, yields would rise. I don't think there should be a concern about that," Novogradac says. "I think the more appropriate question to ask is how low yields can go. You are currently getting 5.92% on 30-year Treasury, and that amount is subject to federal tax. After tax, it's only 3.5%. Obviously yields cannot fall below that. Also, it's a risk- free return in affordable housing."

Some corporations pulling out Boston Capital's Manning says affording housing is still providing pretty good risk-adjusted yield, but some corporate investors have already started pulling out from investing in LIHTC programs.

Major corporations that have pulled back include Camden, N.J.-based Campbell Soup Co., Eli Lilly & Co. of Indianapolis, and San Antonio, Texas- based USAA. Highland, Mich.-based Chrysler Corp. withdrew from investing in affordable housing but has returned lately.

"We have seen some corporations drop out. These are the firms that received much higher rates of return in early '90s," says Manning, adding that those rates are not feasible in the industry today because of the abundance of capital and heated competition.

The good news, however, is that a lot of insurance and financial companies are filling in the gap that was left by these corporations, Manning says. For example, Hartford, Conn.-based Aetna started investing in affordable housing last year.

"The affordable housing industry is quite healthy. There is adequate capital to go around," he says. "More mortgage lenders are participating in this, and it's good because it keeps rates low."

Tax-exempt bonds are hot Edward Marron, president of New York-based CreditRe Mortgage Capital, LLC., a privately held merchant bank that was formed as a joint venture between Credit Suisse First Boston and the Related Cos., LP, says demand for both equity and bonds to provide affordable housing remains unabated.

"The industry has been a bit less efficient in the development process, but it is very healthy," Marron says. "There has been greater pressure for bonds."

Across the country, between $3 billion and $5 billion of qualifying bonds are issued annually by state and local municipal bond authorities, according to Freddie Mac. An additional $10 billion to $20 billion in existing bonds needs to be financed by the year 2000.

To capitalize on the growing tax-exempt bond market, Freddie Mac launched a new multifamily mortgage product in February to provide credit enhancement for multifamily properties financed with tax-exempt bonds. Under Freddie Mac's Multifamily Housing Bond Credit Enhancement Program, borrowers can obtain credit enhancement for properties financed with the proceeds from tax-exempt bonds.

"We are willing to take more risk but manage it through credit enhancement," says Tom Watt, Freddie Mac's senior vice president of multifamily.

Multifamily Housing Bond Credit Enhancement program is the third new multifamily product initiative announced by Freddie Mac in less than a year. Freddie Mac announced a pilot initiative in August of last year to finance new construction of multifamily properties financed with low-income housing tax credits on forward basis and a separate initiative to purchase mortgages on seniors and assisted living properties.

Watt says Freddie Mac is very encouraged by activity in its credit enhancement and guarantee program.

"It will become the third leg of our business. It's an area that has enormous potential," Watt says. "The pipeline is also very strong in our elderly program that is aimed at providing housing for low and moderate elderly."

Taxable tail financing Sidney Grossfeld, national director of the affordable housing division of Altschuler, Melvoin and Glasser LLP, a Chicago-based real estate firm with offices throughout the country, says demand for tax-exempt bonds remains extremely high. The demand is likely to rise further in the future as states increasingly combine tax-exempt bonds with taxable bonds to finance affordable housing.

"This is the wave of the future," says Grossfeld, adding that there are less credits available and the price of those available have skyrocketed, lowering the overall return. "The demand in the market exceeds the supply that exists from low-income housing tax credit and tax-exempt bonds."

He says the combination of tax-exempt bonds and taxable bonds, known as taxable tail financing, has picked up momentum this year.

Charter Municipal Mortgage Acceptance Co. (CharterMac), a New York-based business trust that specializes in the tax-exempt financing of multifamily housing properties, recently acquired a $10 million multifamily housing revenue bond issued by the Norfolk Redevelopment Authority in Virginia. The bond was secured by the Ocean Air Apartment Project, a 434-unit affordable housing project complex in Norfolk, Va. About $3 million was used in taxable debt for the $13 million project, whose renovation is expected to begin this spring.

Although using tax-exempt bonds with taxable bonds together is a creative way of financing affordable housing, it's not a preference, says Jim Spound, senior vice president and director of loan acquisitions of the general partner of the manager of CharterMac. He adds that the use of such combination is appropriate only if either there is no enough qualified cost for project or the public agency does not have sufficient tax-exempt bonds.

CharterMac, whose portfolio is currently comprised of 36 tax-exempt bonds secured by housing in 12 states, originates and acquires tax-exempt bonds, the proceeds of which are used by borrowers to finance and refinance the development and ownership of multifamily housing.

"We do permanent financing for affordable housing, and 90% of our work is in tax-exempt bonds," says Steven Fayne, managing director of Calabasas, Calif.-based ARCS Commercial Mortgage Co. "There is emergence of some privately placed bond deals. It started last year and is picking up a lot of momentum. Most creative credit-enhanced products will hit next year."

Opportunities in rehab Fayne says there is tremendous focus on acquisitions and rehab of affordable housing projects that are eligible for tax credits.

"Most of the housing projects built in the '80s are being converted into affordable housing," Fayne says.

Freddie Mac's Watt says more opportunity in the affordable housing industry lies in rehabs as well as in smaller complexes. He says about one-fourth of Housing and Urban Development Department (HUD) multifamily buildings consist of less than 50 units.

"Only 4% of Freddie Mac's financing is in smaller properties. That represents an opportunity," Watt says. "Smaller loans are between $500,000 and $1 million. It's a question of economics. Smaller projects cannot afford to carry credit. In community development, it's hard to manage smaller properties."

In high cost areas, for example, an apartment unit may cost between $150,000 and $200,000, Watt says.

"It's a lot of money. It's more than single-family homes in many areas," Watt says. "Vacancy began to spike up last year. Many people are moving out of apartments and taking advantage of low interest rates and buying houses."

He says although affordable housing market remains very strong, one must understand its real fundamentals such as new construction, values of the properties and demand and supply situation.

"There are more blinking yellow lights today. We can get into overbuilding," Watt warns. "You cannot make sweeping generalizations, but you could see overbuilding in classic boom-and-bust markets like Atlanta and Las Vegas."

Most of the new construction is taking place in high- and low-end markets, he says. The middle market is being serviced by acquisition of older properties by investors and owners like REITs and pension funds who are renovating those properties.

Freddie Mac and Fannie Mae "Freddie Mac has big stake in the tax credit business," says Watt, adding that Freddie Mac has committed $700 million in low-income housing tax credits that will be funded in installments in seven to eight years through fund syndicators. About 80% of that will go through non-profit syndicators.

"There is tremendous debt and equity capital out there. The early '90s were golden years for lenders. Today, it is different. Building owners and developers are in the driver's seat. Everyone is active," Watt says. "There is also competition from capital markets. It has put a lot of pressure on underwriting standards."

Frank Roberts, an underwriter at AMI Capital Inc., a Bethesda, Md.-based multifamily mortgage finance firm, says Freddie Mac and Fannie Mae, the two major players in multifamily, are getting involved in credit enhancements in a big way and that is bringing efficiency to the market.

The vast majority of Americans support tax subsidies designed to bolster affordable housing across the country, according to a recent survey sponsored by Novogradac & Co., a San Francisco-based public accounting firm that specializes in affordable housing.

The national voter survey, conducted by Los Angeles-based Moore Information Inc., found that 72% of the nation's voters support offering tax incentives to low-income housing developers. This means that more than 7-in-10 U.S. voters indicated that they favor Washington "providing tax incentives to encourage businesses to build low-income housing to both remedy a social burden, as well as stimulate business investment." A mere 19% - or 1-in-5 voters - said they are opposed to this effort.

Here are some other findings from the survey: * Low income housing tax incentives found support from across the political spectrum - registered Democrats, 80%; Republicans, 68%; and Independents, 71%.

* Eighty percent of the voters have heard of Low Income Housing Tax Credit (LIHTC), the 11-year-old program that gives businesses tax incentives to build affordable housing. Of this number, 51% had favorable opinions of the LIHTC; 13%, unfavorable; and 16% had formed no opinion.

* Just 43% of American voters say they have heard of tax-exempt bonds. But those who have heard of the tax-exempt bond program, more voters hold a favorable impression - 22% favorable compared to just 9% unfavorable.

* Sixty-seven percent of voters say they would favor allowing state and federal governments to provide rent subsidies for low-income families, while just 26% opposed .

* Three-in-four voters, or 77%, believe state government is most qualified to handle affordable housing programs for low-income families. At the same time, just 18% think the federal government is best suited to handle these programs.

Not only are there more sources of credit-enhancement today than ever before, but there alsois more demand than ever for low-income housing tax credits. In order to meet the growing demand for tax credits, a serious effort is under way in Washington, D.C. Several bills currently before the U.S. Congress would increase the annual volume cap for the low-income housing tax credit to $1.75 per capita from the current $1.25 per capita. (see box)

The proposed legislation to expand LIHTC would open the door for an additional 180,000 low-income households during the next five years, according to the National Association of Home Builders, a Washington, D.C.-based industry organization which, along with other industry groups, has endorsed the legislation. In addition, the economic impact of the legislation is significant. NAHB estimates this would create approximately 30,000 new construction jobs annually, generating wages of $938 million and $498 million in federal, state and local taxes during development and construction phases.

"There is a very strong bipartisan support to increase the cap. The White House has also endorsed the increase in the caps," says Larry Swank, president of Mishawaka, Ind.-based Sterling Group and chairman of the House Credit Group of NAHB Multifamily Council. "It's a little premature to say when and what will happen with the bill."

"Our No. 1 priority is to seek an increase in per capita housing tax credit allocation," says Jay Harris, project director for NAHB's Multifamily Council's Housing Credit Group. "There is a lot of support for the legislation."

During the past decade, tax credits have led to the creation of more than 900,000 housing units, accounting for approximately 40% of all multifamily housing developed in the country. During the same period, inflation has eroded the tax credit's purchasing power by approximately 45%, industry executives say.

Bills that would increase LIHTC volume cap: S.1252, a low-income housing cap bill sponsored by Sens. Alfonse D'Amato (R-NY) and Robert Graham (D-Fla.), would raise LIHTC to $1.75 per capita and index the credit amount annually thereafter to protect against inflation.

H.R. 2990, sponsored by Reps. John Ensign (R-Nev.) and Charles Rangel (D-NY), the House counterpart to S.1252.

H.R. 3290, a similar bill introduced by Rep. Nancy Johnson (R-Conn.), would make a one-time increase to the cap at $1.75 per capita, index it for inflation and make significant programmatic reforms such as requiring compliance site visits and giving family housing projects priority in allocations.